Use SIP to get power of compounding

We learnt the formula for compound interest during our school days.Here,the basic concept is about earning/paying interest on the principal amount for a predefined period (year,month,quarter,or whatever the time period is) for the first time and then,at the end of each successive predetermined period,its about earning/paying interest on the original principal as well as on the interest that had accrued at the end of the previous period.
Although most investors know about this concept,they often fail to take advantage of the true power of compounding.Or may be they know it as a concept but fail to capitalize on this when they are investing.
Let us take a very basic example of investing Rs 10,000 in a bank that gives you an annual interest rate of 10% per annum.So at the end of the first year,you will have Rs 11,000 in your account and at the end of the second year Rs 12,100.If you remain invested,in about seven and half years your money will double,and at the end of the 10th year,you will have nearly Rs 26,000 in your account that is 2.6 times the initial investment.
Now change the amount,and your final investments will rise exactly by these multiples.
Here,your money doubles in seven and half years.But if you look a little deeper,you will find that the rise in prices of goods and services that is the rate of inflation is at the same rate.So what you can buy today with Rs 10,000 would probably cost you Rs 20,000 in seven and half years.So even if you doubled your money,in effect going by your capacity to buy you will not be better off.
That is why financial planners say that every investors endeavour should be to not only use the power of compounding for his/her investments,but also to have a better purchasing power at the end of the investing period.And that could be achieved by investing in assets that have the power to give returns over and above the rate of inflation.One of those asset classes that usually beat the rate of inflation is stocks.
Although these are risky investments,one could mitigate the risks by investing through the mutual fund route,financial planners say.And here you could use the systematic investment plan route (SIP) to get the power of compounding on your side.
Suppose you are willing to invest Rs 5,000 every month,and the equity funds on an average give an annual return of 15%.So,if you have an SIP and over 10 years get that kind of return,your total investment at the end of the term will be a little over Rs 13.76 lakh.Of this amount,Rs 6 lakh is your own money (that is Rs 5,000 for 120 months),while the rest Rs 7.76 lakh is the return on your investment.
Now if your investment horizon is 20 years,your endof-the-term corpus will be nearly 5.5 times what you got earlier by investing for 10 years that is,almost Rs 75 lakh now.Yes,the numbers look huge but what does the trick here is the power of compounding and your disciplined investment approach.So,think about it and if you are not qualified enough to do it yourself,you should seek help from registered professionals in this field.

Both direct,distributor schemes come with unique advantages

Till last year,if you had decided to invest in a mutual fund (MF) scheme,you would have had to either approach the office of the AMC,its website or your financial adviser.However,from circa 2013,market regulator Securities and Exchange Board of India (Sebi) mandated fund houses to provide a separate plan for direct investments,that is,not through a distributor,in existing as well as new schemes.
Let us take a look at these plans,which came into being from January 1,2013,along with the regular plans,which have become distributor plans.
For investing in direct plans,an investor needs to invest directly with the fund house (physically or online) or at authorised investor service centres of the fund house.In the application,the investor needs to mention Direct in the ARN Code section.The money will thereafter be invested in the dedicated plan of the scheme for such investors.
For investors who use the services of an intermediary,such as a distributor,financial adviser,bank or online portal,the money will be invested in the regular plan of the scheme,along with a mention of the ARN Code of the intermediary.
A major difference between direct and distributor plans is that,by design,they will have separate net asset values (NAVs).In particular,direct plans will have a lower expense ratio compared to their counterparts.This is because direct plans exclude distribution expenses,commission and other similar costs and,further,no commission is paid from these plans.Simply put,such plan pools are treated as separate from the ones accumulated via distributors to which commissions and distribution charges will be applicable,thus requiring a separate NAV.
In effect,investors in these newly minted plans are being rewarded for making efforts for selecting their schemes and approaching the fund house directly to invest.It is important to note,however,that the portfolio of both the plans will remain the same.Lets take an example to elaborate on the point made above.For equity schemes,expense ratios can differ from anywhere between 25 to 100 basis points (100 basis points = one percentage point).This gap in expense ratio will be lower for debt schemes.
Now,say investor A invests a Rs 10,000 lump sum in an equity schemes direct plan which gives him a return of 15% annually.Over 15 years,this would amount to Rs 81,371.Another investor Z,who has invested in the same scheme,has done so through the distributor plan.As a result,he bears an expense ratio which is higher than that of the direct plan by 50 bps.Thus,in the same period,he will earn lower returns (14.5%),which would amount to Rs 76,222,a difference of 6.33% between the resulting amounts of both plans.
From the above,it may seem that investing via direct plans only is the smart way to invest,but this is not necessarily so.You need to remember that to invest in these plans,you need to have had shortlisted your preferred scheme before you go to an AMC office or website or ISC.With 44 fund houses offering thousands of schemes,this is certainly not an easy task.You will need to put in time and effort in doing research for creating your short-list of schemes.
Seasoned investors can opt for this route given their experience in investing in mutual fund schemes,but for new investors with little investment experience,visiting an adviser may be worth the extra return forgone.Apart from providing advice,the adviser will also manage your money,thus saving you the effort of going to the AMC physically.
However,it is important to choose your adviser wisely,because the adviser himself/ herself may end up making all the difference between superior and average returns in your fund portfolio.

Difference between saving and Investing ?

Saving is the money that is left after accounting for all the expenses.

Investing is about the process of growing this money.Left out after all expenses is the surplus.

For example you have seeds of mango. Its silly if you keep it in a box.
Its better we use the seeds and nurture it.

Savings is the raw material and investing is the process.
Inflation will be also around so we need to invest in a proper manner.

Saving and investment are two sides of the same coin.Saving definitely helps to plan for the future but
investing wisely helps to achieve those goals.

"An Evening With Prashant Jain"

Prashant Jain is one of the well respected names in the fund management industry.
Very few can boast of long term track record as he has. He is intelligent, soft spoken, balanced and share good insights.Some of the IFAs (Independent Financial Advisors) in Chennai had the opportunity to listen to and interact with him for close to 2 hours last week. I was one among them. I want to share few things below based on this meeting. This piece is based on what I know and have been sharing with you, what perspectives Prashant shared with us plus my own understandings and observations on the points discussed. So it's a mixture or muesli or kitchidi:-)

1) What's important is to take a broad view for long term. This ensures that we're not blinded by day to news and events. Media focuses on negative news because it sells. Consistent, day to day growth which increases the earnings do not make interesting read and hence ignored. Even in these tough times, earnings have been growing at 15%.

 

2) At current levels markets are trading at less than 14 PE (for FY14). This is lesser than long term averages. Though Sensex is at similar level to 2007, when PE was 28, the PE is now 14, implies earnings have doubled in the last 5 tough years. At 15% annualized growth, the Sensex earnings may cross 2000 in next few years. So it would not be surprise if market touches new highs in the years to come.

 

3) Markets are heavily polarized with some large cap and high quality companies being very expensive and the broader markets being cheap. As interest ratings are peaking, lower rates would be supportive of higher PEs. Earnings growth and higher PEs would lead to good results for investors.

 

 

4) I was surprised to know that the land under agriculture in India is higher than that of China. We are self sufficient in food, vegetables, minerals etc. This is one of the few places where one gets sunshine through out the year. Till few centuries back, India contributed to 25% of the world GDP. We've been growing despite politicians and corruption. We have more number of entrepreneurs in the world.

 

 

5) Every decade after independence, the GDP is growing. Despite volatility in growth rates, it has been in the secular, sustainable, high growth trend. Growth will continue till we get saturated with higher base. For example, in 2001, 3% of our households owned a car. Now it has trebled to 9% of household. It is expected to touch 20% of house holds in 2020. Till 100% of households owns a car (there are countries which have more cars than households), the high growth trajectory can be maintained by an economy. So it looks like we would have good growth rate in the decades to come.

 

6) When the economy is in such a growth trajectory, it is wiser to own equities. Companies, hence equities, will do well in such economies. GDP growth is followed by earnings growth which is followed by equity valuations. Indians missing out a lot by under owning equity. Mutual funds own 3.4% of the total equity which is down from 7% ten years ago. Public shareholding has come down to 14.2% from 22.7% during the same period. FIIs have always been net buyers (except two years- Pokhran nuclear test  2008 Lehman crisis) and they are the ones who are benefiting the most by our growth story.

 

7) Equities are less risky and volatile over long term. Hence it makes sense to invest regularly and also when PE levels are lower. Lump sum investments may be avoided at higher PEs, which is where most investors come and invest. The saving grace is that because of our growth in earnings, even those who invest at higher PEs don't loose out in the long run, though their returns would be muted. The best option is regular and disciplined investing.

 

8) The slowing of growth rate is actually good as it reduces inflation which would reduce interest rates which would increase investments which would increase growth and so on. Slowing consumption is necessary to fix the imbalances in the economy and will overtime result in higher and better quality of growth. As always, these things would continue to be cyclical. As we are in the secular long term uptrend, for an investors who invest regularly and for long term, these cycles don't matter and in fact can even be helpful.

 

9) Gold has had a strong bull run over a decade and medium to long term outlook for it look weak. North America's growing strength in hydro carbon and shale gas may stabilize or lower the oil prices in the medium term. A weak gold and oil prices can do wonders to our deficit and economy. Le us hope for the best!

 

10) In tough times, we tend to think good times never come and in good times, we tend to think it would last forever. Nothing is farther from truth. The truth is things are cyclical and you would do well if you are disciplined in investing and asset allocation. India and its equity markets offer a great scope for building long term wealth. Make use of it to reach your goals and fulfill your aspirations.